The Ineligibility of Collusive Transactions as “Financial Debt”: Part II

[Continued from here]

Analysis and Observations

Through its decision in Phoenix Arc, the Supreme Court has added to the wealth of jurisprudence under the IBC. At the same time, several questions remain.

Collusive Transactions

Perhaps the broadest and most impactful interpretation of the Court lies in the question of whether collusive transactions give rise at all to “financial debt” within the meaning of the IBC so as to constitute the transacting parties as “financial creditors”. This is a crucial question given the prominent status conferred upon financial creditors under the IBC, particularly when it comes to influencing decisions taken by the CoC. It is not surprising that the issue of financial creditorship has repeatedly arisen before the judiciary, including the Supreme Court.

The Court’s task in Phoenix Arc was compounded by the fact that the legislative provisions in sections 5(7) and 5(8) did not explicitly provide for the nature of the transaction (whether genuine or collusive) that would lead towards a financial debt. Hence, the Court effectively read in the requirement into the sections that the transactions ought not to be in the nature of collusive or sham transactions. This much is understandable, as no party may be allowed to take advantage of a legislative benefit generated through its own wrongdoing, as that would militate against the purpose of the legislation and lead to absurdity in outcome. However, the use of collusion or sham as yardsticks to deny financial creditorship could lead to unintended consequences.

Expressions such as collusion and sham, while useful as judicial tools, could lead to uncertainties, as they conferred tremendous amount of discretion to the courts and tribunals. Recognising this, courts in other jurisdictions and in related areas of the law such as piercing the corporate veil have embarked upon the task of eschewing the use of labels (see for instance the ruling of the UK Supreme Court in Prest v. Petrodel Resources Limited, noting that the “difficulty is to identify what is a relevant wrongdoing. References to a “façade” or “sham” beg too many questions to provide a satisfactory answer.”). In engaging in a purposive interpretation that led to an appropriate outcome, the Court may have opened the Pandora’s Box by invoking the labels of collusive and sham transactions without necessarily outlining the contours of these labels. The Court’s analysis appear motivated to settle the dispute on hand based on the facts of the case rather than to undertake a jurisprudential exercise with an eye on the stare decisis principle.

The absence of clear guidance on the nature of collusive or sham transactions that could disentitle persons to be treated as financial creditors could not only confer a great deal of discretion on the adjudicatory authorities under the IBC, but it could also lead to an increase in litigation on this usually threshold question of whether a person can be treated as a financial creditor at all. While legislative fine-tuning could be a solution, it has the risk of operating in a narrow sphere. Perhaps a more desirable outcome would be for the Supreme Court to offer more detailed guidance, an opportunity it denied itself in Phoenix Arc.

Related Parties

The issues surrounding the nature of relationships that would cause a person to be excluded from the CoC’s decision-making process is relatively more straightforward, not least due to the enumeration of specific relationships in section 5(24) of the IBC. The Court only had to engage in an interpretation of rather explicit statutory provisions. The ruling in Phoenix Arc clarified the impact of this provision on a few areas. First, the case demonstrated the extensive nature of relationships that the legislation encompasses. It operates on a two-way basis, i.e., whether (i) the corporate debtor has control over the related party, or (ii) vice versa.

Second, in the defining the relationships, IBC has employed a wide range of factors thereby making the provision quite extensive. For instance, section 5(24)(h) provides that a related person is “any person on whose advice, directions or instructions, a director, partner or manager of the corporate debtor is accustomed to act”. It is not necessary for the related party to exercise influence over the entire board, or even a majority thereof, of the corporate debtor. Influence over even one of the directors, managers or partners is sufficient, and nothing more needs to be demonstrated. Moreover, section 5(24)(m)(i) treats a person as a related party by virtue of “participation in policy making processes of the corporate debtor”. Here, mere participation is sufficient, whether that leads to any exercise of influence or not. These definitions of related parties are indeed a lot wider than related concepts such as whether a person is a “shadow director” of the debtor company (which usually requires significant influence over the board) or even whether such person has “control” over the debtor company. In fact, in Phoenix Arc, the Court rightly rejected the definition of “control” (as articulated by it in Arcelor Mittal India Private Limited v. Satish Kumar Gupta)for the purposes of section 29-A of the IBC as not having a bearing for determining related parties.


The issue of timing as to when the relationships must be considered to determine whether they fall within the definition of related parties arises due to arguably inelegance in the drafting of the proviso to section 21(2) while it was amended in 2018. The phrase “is” was introduced by the amendment, which the Court found “was not a guiding factor behind the Parliamentary amendment.” The reason for the amendment was rather to extend the amendment beyond the financial creditors also to their authorised representatives. Here, the Court was right to engage in a purposive interpretation of the statutory language because a literal interpretation could have resulted in incongruity. While this situation could have been avoided by more astute legislative drafting, perhaps it is useful to relook at the language of the proviso to section 21(2) given that the linguistics were subject to threadbare discussion in Phoenix Arc.


As mentioned earlier, while the Supreme Court in Phoenix Arc has clarified some key aspects of financial debts and related parties, some questions still remain to be addressed either legislatively or judicially. From a jurisprudential perspective, it is the case that the Supreme Court could have simply arrived at its ruling based on the fact that Spade and AAA were not financial creditors. However, the fact that it nevertheless chose to proceed with the further consideration of questions such as whether Spade and AAA were related parties and also the relevance of the timing of the relationship begs the question whether its rulings on the substantive law on these points represent merely obiter dicta.


About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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